You Never Give Me Your Money: Initial Recipient of Funds is Not Always a “Transferee” Liable for Fraudulent Transfers

In a recent summary order in an appeal from a bankruptcy court, the United States Court of Appeals for the Second Circuit reaffirmed that mere receipt of a fraudulent transfer is not always sufficient to render the recipient an “initial transferee” strictly liable to return the funds to the trustee under section 550(a)(1) of the Bankruptcy Code. In other words, just because a person or entity received a transfer that is later determined to be fraudulent does not necessarily mean that the recipient is liable to a bankruptcy trustee for those funds.

In Jalbert v. Gryaznova (In re Bicom NY, LLC), No. 21-1821 (2nd Cir. May 5, 2022), the Defendant (Ms. Gryaznova) had opened a joint bank account with the debtor’s principal, Benjamin Nilva. The evidence indicated that the account was intended only to hold the Defendant’s own money while she established her permanent residency in the United States. Years later, Nilva was saddled with financial troubles and decided to move funds between his businesses in an effort to shield them from his lenders. Nilva routed $1 Million from the debtor to the joint account with the Defendant, where it remained for two days, then moved the funds on to another of his businesses, via a forged check in the Defendant’s name in order to hide the source of the funds.  When the debtor subsequently filed for bankruptcy, the trustee for the debtor’s bankruptcy estate sought to avoid and recover the $1 Million transfer from the Defendant as the “initial transferee.”  The bankruptcy court entered summary judgment in favor of the Defendant. The trustee appealed to the district court, which affirmed the ruling, and the trustee then appealed to the Second Circuit.

On appeal, the Second Circuit noted that, once a transfer is avoided as fraudulent under section 544 or 548 of the Code, the “initial transferee” (unlike a subsequent transferee) is strictly liable to return the transferred property or the value of the transfer to the estate under section 550(a)(1) – that is, even an initial transferee that is innocent of any wrongdoing and has acted with the utmost good faith has no defense to the trustee’s ability to recover the property or funds at issue. Yet the term “initial transferee” is not defined in the Code, leaving courts to determine who may qualify as an “initial transferee.” On that question, the Second Circuit reaffirmed a principle that it had previously adopted in a decision in 1997, i.e., that “the term ‘initial transferee’ references something more particular than [being] the initial recipient.” The court thus “declined to ‘equate[] mere receipt with liability,’” and held that “mere conduits” of fraudulent transfers are not initial transferees under section 550(a)(1).

On the facts before it, the Second Circuit rejected the trustee’s contention that the Defendant was an initial transferee merely because she briefly had the hypothetical ability to control the funds, or even walk out of the bank with them, while they were in the joint account.  While the court acknowledged that the Defendant was the initial recipient of the $1 Million transferred by the debtor, since she was a co-owner of the joint account, it concluded that this fact alone was “insufficient to confer ‘initial transferee’ status” on the Defendant. Rather, “[a]lthough she hypothetically could have exercised control over the funds because they were in the joint account for two days, it is undisputed that she never had ‘a realistic opportunity to’ use the funds because she did not know about them. Indeed, she had no reason to suspect that Nilva would use the joint account in this manner based on their agreement that the joint account was to hold only her money, not his.” On this basis, the Second Circuit concluded that the district court (and the bankruptcy court) had correctly determined that the Defendant was a “mere conduit” of the fraudulent transfer at issue, and therefore could not be liable to the bankruptcy estate “for funds she never knew about.”

While the facts in the Bicom NY case are somewhat unusual, the Second Circuit’s decision likely has broader applicability. A defendant in a fraudulent transfer case may have a defense where, even though it was the initial recipient of the funds at issue, it had no knowledge of the transfer of funds and/or no realistic opportunity to possess or control the disposition of those funds.  At a minimum, the decision provides at least one possible, fact-driven exception to the more general maxim in bankruptcy that, once a transfer is found to have been fraudulent under section 544 or 548 of the Bankruptcy Code, an initial transferee under section 550(a)(1) is strictly liable for the return of the funds to the bankruptcy estate.